For many homeowners Adjustable Rate Mortgages have a bad name and are overlooked completely when refinancing. While it’s true that Adjustable Rate Mortgages are riskier than their Fixed Rate counterparts, when used properly they can save you thousands of dollars. Here are several tips about the pros and cons of Adjustable Rate Mortgages to help you decide if a variable rate mortgage is right from you.
What Are The Risks of Adjustable Rate Mortgage Refinancing?
The risk with this type of mortgage refinancing comes from the potential of experiencing payment shock. Payment shock occurs when the lender adjusts your payment amount or recasts the loan and you can no longer afford to make your mortgage payment. This typically happens with Adjustable Rate Mortgages that do not have their caps structured properly or with homeowners that abuse the so called “Payment Option” loans.
When Use Properly Adjustable Rate Mortgages Have Very Little Risk
Adjustable Rate Mortgages typically come with a low, fixed introductory interest rate. This rate is often much lower than the actual contract rate, and in the case of Hybrid Adjustable Rate mortgages this introductory period can last as long as five to seven years. If you plan on selling home within five to seven years you could take advantage of this introductory period to lower your payment amount with little or no risk.
Adjustable Rate Mortgages Come With Safety Features
Caps protect homeowners from abrupt changes in their adjustable mortgage rate and payment amounts. There are two types of caps you need to be concerned with; periodic caps that limit the amount your interest rate can go up or down and payment caps that limit how much your mortgage payment can change. Both have the option of lifetime caps which limits the change over the duration of your loan. When you refinance your mortgage with an Adjustable Rate Mortgage make sure your loan has both payment and periodic caps. Loans that have only payment caps are prone to negative amortization when the cap prevents the payment going up enough to cover an increase in the mortgage interest rate.
Be Careful Refinancing With Payment Option Mortgage Loans
Option Adjustable Rate Mortgages have become extremely popular due to their flexibility and the “optional” minimum payment amount. The option mortgage gives you the choice of making a payment based on a 15 or 30 year amortization schedule, an interest only payment, or the “optional” minimum payment.
When you make the minimum payment you are not paying enough to cover the mortgage interest due that month and the outstanding amount is added to your loan balance. This is called “negative amortization” and it means your loan is actually growing over time. Homeowners who abuse the minimum payment will find that the lender automatically recasts the loan when they reach a certain threshold of what they owe. When this happens the loan is converted to a standard Adjustable Rate Mortgage amortized for the time remaining on the contract.
Many homeowners who abuse Option Adjustable Rate Mortgage loans can barely afford the minimum payment; when the lender recasts their loans they are one step away from foreclosure and frequently lose their homes. You can learn more about your Adjustable Rate Mortgage refinancing options, including expensive pitfalls to avoid with my free mortgage toolkit. You can register for the free toolkit with no obligation now or ever using the links at the top of this page.
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
